Here’s the question: Are you getting the right loan and borrowing the right way so you do all you can to ensure that you can get the next loan you’ll need for the continued growth of your business?
Some entrepreneurs think that the only goal of borrowing is to get approved or just to have some form of financing they can use. But it’s bigger than that. It’s actually common for businesses to grow and then to need additional capital to propel themselves to the next level. It’s also common for things like debt and credit mistakes to stop them from qualifying for that additional capital.
Here are the four biggest dangers of borrowing money the wrong way when building a business:
1. Allowing Lenders to Take Too Much Collateral With a Loan
This one can be a bit difficult if you’re not familiar with choosing the right bank to work with. Here are some questions to ask yourself:
- Can you borrow the money you need without pledging any collateral to the bank? Some banks require collateral on all loans; other banks will extend certain types of loans or lines of credit without any collateral requirements.
- What is a reasonable collateral request based on the loan you’re requesting? If you’re looking for millions of dollars for a large expansion, you’re not going to get it without collateral. However, if you only need $50,000 or $100,000 for working capital or financing some receivables, you’re an established business and you’ve got good personal credit, then you may be able to get that financing without needing collateral.
You will need to work with a good person at the right bank, but you get the idea.
2. Not Being Committed to Maintaining (or Improving) Your Personal Credit
Although bank financing is challenging to get, it’s always going to be the cheapest form of funding your business. There are “alternative” financing options galore but it should always be your goal to get your business to be “bankable.” In other words, you want to be able to obtain your loans and lines of credit from a bank.
As a small business owner, your personal credit is normally one of the key ingredients in the underwriting process to see if your loan request will be approved. If you have excellent credit, maintain it. Don’t let yourself get “too busy” to pay your bills on time. Don’t use your personal credit cards for business expenses – this is possibly the biggest credit mistake made by small business owners. If your credit needs improvement, then be proactive about improving it. Your business will thank you.
3. Not Knowing the Impact of Your Loan on Your Budget and Cash Flow
We would probably all agree that excessive debt is never a good thing for any business. But what impact does the loan have on your budget? There are two important factors here:
- Use the funding you obtain for RGA (revenue-generating activities). If you grow the business with your loan or line of credit, then you’ll probably be able to justify the impact the loan has on your budget and cash-flow.
- Keep in mind that cash flow is usually more important than interest rates. In other words, if you can extend a loan from a three-year repayment period to four or five years in exchange for a little higher interest rate, consider what lower payments mean to your budget and cash flow. If that saves you $150 a month in the form of a lower payment then it may be your best bet. If you end up growing faster than you project and your cash flow is excellent, you can pay that loan off at an accelerated pace. However, if your growth is slower than you expect or you have tight cash flow, you’ll be glad you extended the terms.
4. Choosing the Wrong Loan for Your Purpose
Do you need a loan or a line of credit? Based on your credit, business, industry, collateral, revenue, profit, etc., do you know what your borrowing options are? If you understand what your options are, you can choose the loan solution that’s best for you.
I recently worked with a printing company that requested a factoring facility but they actually qualified for an unsecured business line of credit from a bank. That meant a lower cost, no UCC lien against the business, and no notification to their creditors about selling their receivables to a third party. Although they qualified for a lending solution that was “better” than they thought, it’s probably much more common for small business owners to think they can get bank financing when they really are not “bankable.”
My conclusion brings me to my two favorite words in business: knowledge and execution. Know your borrowing options (most small business owners don’t) and then execute. Period. Get your funding, use it for RGA, and keep living the dream!
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